Market Power and Efficiency in a Search Model

Abstract

We build a theoretical model to study the welfare effects and resulting policy implications
of firms’ market power in a frictional labor market. Our environment has
two main characteristics: wages play a role in allocating labor across firms and there
is a finite number of agents. We find that the decentralized equilibrium is inefficient
and that the firms’ market power results in the misallocation of workers from the high to
the low-productivity firms. A minimum wage forces the low-productivity firms to
increase their wage, leading them to hire even more often thereby exacerbating the
inefficiencies. Moderate unemployment benefits can increase welfare because they limit
firms’ market power by improving the workers’ outside option.